At this week's sixth Democratic presidential debate, senators Bernie Sanders and Elizabeth Warren reiterated their call for a U.S. wealth tax, which as some estimates hold, would affect 75,000 families and raise $2.75 trillion over a 10-year period.  

The wealth tax alone can "provide universal child care, early childhood education for every baby in this country, age 0 to 5, universal pre-K for every 3-year-old and 4-year-old, and raise the wages of every child care worker and preschool teacher," said Warren at the debate.

The problem--for U.S. entrepreneurs at least--is that while the tax may not overtly affect them, it could affect investors, and that could lead to a slowdown in venture funding. It would also contribute to a considerable increase in uncertainty--particularly in the months or years that Congress and possibly the Supreme Court weigh the matter.

I'll get into how exactly this could happen in a moment. First, let's start with some definitions. The wealth tax is essentially just that: a tax not on income but on what is considered personal assets or "wealth." This could include property, art, jewelry, and financial wealth like stocks. Sanders and Warren, who have both proposed a version of the tax, are suggesting wealth taxes of around 2 percent annually for wealth above about $30 million and $50 million, respectively. The aim, as indicated by their respective websites, is to combat inequality by ensuring that those who make the bulk of their large wealth outside of their income "pay their fair share" in taxes.

For entrepreneurs, should this pass, you're looking at fewer investor options, as the wealthiest Americans--which include plenty of angel investors and investors in venture capital funds--begin to consume more, and save and invest less. While Warren and others prefer to explain it as a 2¢ tax, meaning 2¢ per $1, it is actually a percentage tax, or 2 percent of wealth. Investors typically make investment decisions not about how many cents per dollar they are making but rather their percentage return. Here's how the math shakes out: Since the S&P 500's average return for the past 90 years has been around 9 percent, an 8 percent wealth tax would effectively wipe out the returns to that investment. Another way of looking at it is that if your wealth is growing at 5 percent a year, a 3 percent increase amounts to a 60 percent tax on that growth.

Let's further imagine that today's under-resourced IRS, which can hardly police income taxes, manages to additionally collect this wealth tax. Any new law would face significant legislative and even legal hurdles that could take months or years to unravel. Some legal experts believe there are provisions in the U.S. Constitution and precedence in case law that forbid federal taxation of private property, among other legal arguments. Thus, while it is unclear what the eventual outcome could be, what is clear is that this legislation would spend a long time being debated in Congress and perhaps the Supreme Court, where lawyers for the wealthy will surely challenge the validity of this policy.

What the wealth tax does--more than anything else--is create uncertainty. Uncertainty is what kills markets, causes credit to dry up, and pushes investors to the sidelines.

It's not to say that raising taxes is always a bad idea. Instituting an entirely new tax regime, however, may be more trouble than it's worth. In reality, we can use the existing system to generate more tax revenue without being as disruptive. For instance, economists Natasha Sarin and Larry Summers suggest that if the government simply ramped up efforts to audit the wealthy, a large chunk of missing tax revenue--approximately $1 trillion--could be collected with no new taxes necessary or any new policies.

The problem is that this solution and others--such as capping tax deductions for the wealthy--are not sensational and don't make election-year headlines. I would argue that throttling the U.S. economy isn't a headline any politician should want to aspire for. But that's just where this wealth tax is going.

Published on: Dec 20, 2019
The opinions expressed here by Inc.com columnists are their own, not those of Inc.com.